The veteran strategist thinks the market is “vulnerable to a correction.”

By Byron Wien

Donald Trump swept into office on a populist wave. His promise of greater growth for the United States economy resonated with a large part of those disappointed with stagnant wages and a lack of opportunity.

He said he would bring manufacturing jobs back and provide better health care coverage at a lower cost. All politicians know that they can make promises during a campaign that voters will not remember or that they will understand an administration not being able to accomplish, but the new team in Washington has an ambitious agenda and is off to a slow start. Trump has said that he expects to bring real GDP growth up to 4%, but he will be doing well if his stimulative initiatives result in 3% growth. We have been below 2% since the recovery began in 2009, the slowest comeback in the post-World War II period.

As I see it, there are three impediments standing in the way of significant progress. The first is the difficulty of getting an effective team in place and working out a set of operating procedures within the White House, with Congress and with our traditional foreign allies. The President has had some disappointments in assembling his team – first with the resignation of his National Security Advisor over relations with Russia and second with the recusal of his Attorney General in matters related to Russian involvement in the U.S. election. On the heels of this setback, the Trump tweet alleging that former President Obama tapped the Trump Tower telephones during the campaign distracted the White House from dealing with its pro-growth initiatives. The president has not backed down from his view. This first phase is largely behind us now with most of the cabinet positions filled.

An imperative for the White House has been to get going on its legislative agenda. The electorate and the investment community are counting on it. Donald Trump put repealing the Affordable Care Act first. This was probably a mistake similar to the one both Barack Obama and Bill Clinton made when they tackled health care right away when they took office. Creating a program of universal coverage that both individuals and the government can afford is a monumental task and the present Obama program has flaws that would require changes no matter who was in the White House. In my view, the Trump repeal and replace program failed for three reasons.

First, the so-called Freedom Caucus of 30 conservative Republican Congress people was dissatisfied with some of the mandated health care benefits and believed that the problem of rising premiums was not adequately addressed. They were never going to be persuaded to vote for the legislation in its present form.

The bill had some creative solutions to major health care problems, such as the establishment, with Federal support, of high-risk “pools” for people with pre-existing conditions. But the bill had too many critics among both moderate Republicans and Freedom Caucus members. As a result, the House Majority Leader fell short of the 216 votes he needed and he pulled the bill rather than face the humiliation of having it turned down in a floor vote.

The second reason it failed was that too many people were either going to lose coverage, have it diminished or see their health insurance costs rise significantly. The Affordable Care Act has brought the percentage of uninsured Americans down from 18% to 11%. Approximately 20 million additional people are covered and many of them (perhaps 15 million according to the Brookings Institution) would lose coverage under the Ryan plan. That’s why there was no Democratic support.

The third reason was that the House leadership and the administration failed to go through the tedious effort of explaining the bill and selling it to Congress. This takes time, but the administration seemed to be in a rush to move on to other items on the agenda. I hope this is a lesson learned and it won’t be repeated.

The second challenge will be tax reform and this has only been made more difficult by the failure of the health care bill. Donald Trump promised a reduction in taxes for individuals and corporations, while keeping the process “revenue neutral,” meaning it will require no increase in the budget deficit. If the top brackets for both corporations and individuals were brought down to 20% and 25%, respectively, the loss of revenue would be considerable. The blended rate that corporations actually pay is probably close to 27%, so the gap is not as great as it appears. The cut to the top bracket for individuals represents a more severe revenue loss, although at least some of that can be retrieved by limiting deductions. Creating a limit on deductions would hurt big earners who live in states with high local income taxes like New York and California, but these states voted for Hillary Clinton and Trump has little compassion for them (although Republican representatives in these states might have more).

Limiting deductions will not solve the “revenue neutral” problem, however, and major funds will have to be found elsewhere. The major potential sources are the elimination of interest deductibility and the border adjustment tax. The real estate industry is among those that would be hurt considerably by the former, and the retail industry would be hurt seriously by the latter. Both groups are vociferously making their views heard in Congress. The result is that the tax reduction plan is moving forward very slowly. Because lower taxes were going to be one of the pillars of bringing economic growth from 2% to 3%, any delay works against Trump’s objective of improving incomes and creating jobs this year.

None of this was unexpected. We all knew that progress would be slow and frustrating in Washington, but it is especially daunting for a President who is impatient and new to the political process. But the American people can also be impatient. They voted for him because they were tired of a government that accomplished little and they yearned for change. The longer change is delayed, the more dissatisfied the electorate is likely to be. Campaigning, with its roaring crowds and debate confrontations, is finite and easy. Governing, with its frequent meetings and continuous negotiations, is endless and hard.

Beyond tax reform, the Trump budget is clearly testosterone-oriented, as David Brooks noted. There are increases for Defense, Homeland Security and Veterans Affairs and significant cuts to the Environment Protection Agency, the State Department and Agriculture. The objective is to keep America safe and strong right now while long-term problems have been shifted to the back burner. There is no effort, for example, to address entitlements. But in the 2040s, the percentage of the U.S. population over age 65 as compared to the population between the ages of 15–64 will rise to 34%. It is less than 20% now. Who will support these people?

The new administration is fortunate that the natural momentum of economies around the world is reasonably strong. The payroll report for the U.S. in February was positive, clearing the way for the Federal Reserve to raise interest rates in March, and we are likely to see at least two more rate hikes this year, assuming the stock market and the economy continue to move forward. Consumer net worth rose 8.6% in the first quarter of 2017, indicating that the buying power exists for a growth rate of 3%, but the problem is that the distribution of wealth is very uneven. Too much money is in the hands of the top 10% and their propensity to spend is relatively low. The middle 50% have not seen their real incomes grow since 2000 and they are not likely to become vigorous consumers until the tone of the economy improves and there is a greater prospect of wage increases. Recently, however, wages have been rising, with average hourly earnings showing a 2.8% increase in February. This raises the question of inflation, which is ticking up, but is not yet at worrisome levels. Wages are high enough to bring some people back into the workforce, and the participation rate has risen to 63%, which is a favorable development. The participation rate had dropped from 66% prior to the 2008–09 recessions to 62% at the trough.

The Bloomberg Consumer Comfort Index is back to its 2007 level, indicating that the mood for buying is ripe, but it may require a catalyst to get it going. A reduction in taxes might do the job. Initial unemployment claims are lower than they have been in more than 40 years. The rig count is up sharply, indicating the energy industry has started drilling again, which should improve capital spending generally.

Railcar loadings have also turned up, housing data is positive and leading indicators are rising. The data from Europe shows growth should approach 2% and China, India and Japan are demonstrating a favorable pace in their economies. A U.S. recession appears at least two years away, so even if the new administration accomplishes nothing on the legislative front, the economy is likely to be okay. However, Trump is counting on showing the American people he has made a difference and additional stimulus will be required for that to happen.

As I said at the beginning, there are three impediments to the Trump administration making significant economic progress in its first year. The first is assembling a team and getting it working effectively. The second is getting his legislative agenda moving, and he has already run into trouble. The final impediment is structural problems in the U.S. economy.

The principal factors producing growth are increasing population and productivity. Population in the U.S. has been increasing at only 1% annually and productivity at less than 1%. As a result, most academic economists, most notably Robert Gordon of Northwestern University, believe growth is likely to be less than 2% going forward. Goldman SachsGS in Your ValueYour ChangeShort position and others believe the productivity numbers are understated by about 0.5% because of the difficulties of factoring in the contribution of technology, primarily software, to productivity improvements. Others believe that the hollowing out of the middle class as a result of globalization and technology has limited growth by reducing buying power. In any case, the supply side stimulus provided by tax cuts, reduced regulation and infrastructure spending would appear to be needed to achieve 3% growth.

There are, however, other problems. We all know that per capita income increases have been disappointing as a derivative of low real GDP growth. Ned Davis Research has done a study of real disposable income on a 10-year percentage change basis. This measure has declined sharply from 1970 (the end of what Robert Gordon refers to as the “special century”), when it was 47%, to the current level of 10%. At the same time the savings rate has declined from the 1960s, when it was in the teens, to 3% today. Personal consumption expenditures have increased as a percentage of disposable income from 81% in 1970 to 91% now as consumers have borrowed to maintain a comfortable lifestyle. In addition, making major improvements in productivity and GDP is difficult because of other secular forces like the breakdown of the family structure, increased opiate usage among younger people, the growing prison population, and the large numbers of people on disability. Where are the workers going to come from to enable the U.S. to grow faster? I am grateful to Commentary magazine for articles by Nicholas Eberstadt and James Pethokoukis providing background on factors affecting American growth.

There are two other secular factors that could have a profound effect on growth. One is artificial intelligence, which could diminish the number of people working in white collar jobs. This could be a case of increasing productivity but with the attendant effect of reducing the income of a significant part of the population. The second is a potential decline in entrepreneurship. According to the Financial Times, since the late 1970s start-ups as a percentage of all firms have fallen by more than half and the number of workers at these firms has fallen by three-fourths. A study by the Kaufmann Foundation has found that high-impact growth entrepreneurship has largely recovered from its 2008–09 recession slump. Given that small business start-ups are key to economic growth, the improvement in this trend is important.

One question that has to be raised by the failure to pass the health care bill is whether there is too much anarchy in Congress for any major legislation to get through in spite of the Republican majority. This has to make one a little apprehensive about how quickly the economy will improve to the 3% growth level. This could put my estimate of earnings for the Standard & Poor’s 500 in jeopardy and mean that the stock market is ahead of itself and vulnerable to a correction. I still think higher highs are ahead of us, but they may occur later than I originally thought. It will also be important to see how Donald Trump deals with legislative adversity, disagreements with foreign leaders over trade and defense, and geopolitical confrontation (North Korea). These factors will play a critical role in investor attitudes and market performance.

Wien is vice chairman of Blackstone Advisory Partners, a subsidiary of the Blackstone Group.Your ValueYour ChangeShort position

We are travelers on a cosmic journey, stardust, swirling and dancing in the eddies and whirlpools of infinity. Life is eternal. We have stopped for a moment to encounter each other, to meet, to love, to share.This is a precious moment. It is a little parenthesis in eternity.